The Court of Appeal in London today gave judgment in the Waterfall I Appeal, a dispute as to the distribution of the estimated £7 billion surplus of assets in the main Lehman operating company in Europe, Lehman Brothers International (Europe) (LBIE).

LBIE entered administration on 15 September 2008 and has now paid its unsecured creditors 100p for every £1 owed.  The Waterfall I Appeal addressed some of the key issues as to who should receive the surplus, which we discuss below.

Currency Conversion Claims

Many of LBIE’s creditors have claims originally denominated in US Dollars.  Their claims were converted to Sterling on 15 September 2008 for the purposes of claiming and being paid in the LBIE administration.  Due to the subsequent weakening of Sterling against the US Dollar, these creditors are estimated to have suffered FX losses of £1.3 billion.

The Court of Appeal upheld David Richards J’s finding that, in the event of a surplus after all unsecured creditors have received 100p in the £ on their proved debts plus statutory interest, creditors are entitled to be paid their currency losses before anything is distributed to shareholders.

The losses are calculated broadly as the difference between: (i) the amount of the contractual entitlement to payment in the original currency; and (ii) the dividends paid in Sterling, converted back to the original currency at the date of payment (a Currency Conversion Claim).

Briggs and Moore-Bick LJJ held (with Lewison LJ dissenting) that a creditor’s right to payment in its original contractual currency was converted into Sterling as at the administration date “for the purpose of proof” only.  They held that the conversion is not a permanent alteration to that creditor’s contractual rights.

Briggs LJ held that “there is nothing in the Act or in the rules which prevents the foreign currency creditor reverting to his contractual rights, once the process of proof (and payment of statutory interest) has run its course, if there is then a surplus.”

In his dissenting judgment, Lewison LJ stated that: “it is impossible to suppose that when rule 2.86(1) and rule 4.91(1) were introduced Parliament intended to split a unitary obligation to pay a sum in a foreign currency into two claims, one of which was provable and the other of which was not.”

Ranking of subordinated debt

The Court considered whether LBIE’s subordinated debt of approximately £1.25 billion should be repaid before or after statutory interest and Currency Conversion Claims.

By reference to the terms of the relevant subordination agreements, the Court held that the subordinated debt is a contingent debt payable only after LBIE has paid statutory interest and non-provable liabilities (including Currency Conversion Claims) in full.

Administration statutory interest

Overturning the judgment of David Richards J, the Court held that statutory interest accrued but not paid in LBIE’s administration is payable in a subsequent liquidation to creditors who proved in the administration.

Liability of LBIE’s members as contributories

LBIE is an unlimited company and therefore its shareholders, LBL and LBHI2, are liable pursuant to section 74 of the Insolvency Act to contribute sufficient funds to pay LBIE’s “debts and liabilities.” Agreeing with David Richards J, the Court held that “debts and liabilities” means “all the liabilities of the company at all stages of the waterfall”, including statutory interest and non-provable debts.

The power to make a call on members pursuant to section 74 is delegated by the Court to the liquidator, but not to an administrator.  The Court agreed with David Richards J that, in spite of this, LBIE’s administrators are entitled to prove in the insolvencies of LBL and LBHI2 in respect of their contingent liabilities to pay calls under section 74.

Finally, the Court held that the contributory rule, which prevents a member from recovering anything in a liquidation until it has discharged its liability as contributory, should not be applied in a distributing administration.  The Court agreed with David Richards J that it would be a serious injustice to prevent a solvent contributory from proving in a distributing administration on the basis of a contingent future liability to a call.

Nevertheless, because the contributories’ contingent liability is provable, it will be set off against their claims in the administration.

Comment

The appeal judgment addresses extremely high value and novel issues arising in the event of a surplus in an insolvency.  It is a very important statement as to the effect of the insolvency regime on creditors’ contractual rights, and provides for the existence and ranking of approximately £1.3 billion of non-provable claims for currency losses.